State may need to ask U.S. for $7-billion loan

Tight credit has dried up funds California routinely relies on.

SACRAMENTO — California Gov. Arnold Schwarzenegger, alarmed by the ongoing national financial crisis, warned Treasury Secretary Henry M. Paulson on Thursday that the state might need an emergency loan of as much as $7 billion from the federal government within weeks.

The warning comes as California is close to running out of cash to fund day-to-day government operations and is unable to access routine short-term loans that it typically relies on to remain solvent.

The state of California is the biggest of several governments nationwide that are being locked out of the bond market by the global credit crunch. If the state is unable to access the cash, administration officials say, payments to schools and other government entities could quickly be suspended and state employees could be laid off.

Plans by several state and local governments to borrow in recent days have been upended by the credit freeze. New Mexico was forced to put off a $500-million bond sale, Massachusetts had to pull the plug halfway into a $400-million offering, and Maine is considering canceling road projects that were to be funded with bonds.

For The Record Los Angeles Times Saturday, October 04, 2008 Home Edition Main News Part A Page 2 National Desk 1 inches; 39 words Type of Material: Correction California loan: An article in Section A on Friday about a $7-billion emergency loan that California may seek from the federal government misspelled the last name of Robert Feyer, an attorney advising the state on bond issues, as Fayer.

California finance experts say they know of no time in recent history when the state has sought an emergency loan of this magnitude from the federal government. The only other such rescue was in 1975, they said, when the federal government lent New York City money to avoid bankruptcy.

"Absent a clear resolution to this financial crisis," Schwarzenegger wrote in a letter Thursday evening e-mailed to Paulson, "California and other states may be unable to obtain the necessary level of financing to maintain government operations and may be forced to turn to the federal treasury for short-term financing."

The letter, obtained by The Times, came on the eve of a vote by the House of Representatives on a $700-billion rescue package, but it was too soon to know how the package would affect the nation's paralyzed credit markets. The Senate approved the so-called rescue bill Wednesday night.

A top Schwarzenegger aide followed up the letter with a call to the Treasury secretary Thursday night. Treasury Department officials could not be reached for comment.

It's customary for California to borrow billions of dollars at the start of the fiscal year to fill its coffers until the usual flood of sales tax receipts comes in after Christmas and income tax receipts arrive in the spring.

"California is so large that our short cash-flow needs exceed the entire budget of some states," Schwarzenegger wrote.

The cash needs to be in the state's bank account by Oct. 28 to be available to fund a scheduled $3-billion payment to more than 1,000 school districts.

Said Matt David, Schwarzenegger's communications director: "California faces the potential of a perfect storm created by the financial crisis' effect on liquidity, lower-than-anticipated revenues currently coming into the state, and our late budget. The governor is taking steps to prepare for this scenario to ensure that the state can make critical payments."

But those payments won't be forthcoming if the state can't do routine borrowing. For now, "the window is shut, and if it stays shut, we are in deep trouble," said an administration official, who asked not to be identified, citing the sensitive talks with Washington.

Quick passage of the rescue bill by the House of Representatives today and a signature by President Bush could inject more money into the international financial system and allow California to borrow at a reasonable interest rate, the official said.

But there are no guarantees that the economic recovery plan before Congress will succeed, said California Treasurer Bill Lockyer, who has been working with Schwarzenegger to keep the state solvent.

Asking the federal government for a loan "is one option on the table," said Tom Dresslar, a spokesman for Lockyer. The treasurer, he added, is working with outside financial advisors on a possible emergency plan to sell short-term debt notes to the U.S. government. Lockyer believes that such a plan is both feasible and legal, Dresslar said.

"I don't think we have ever gone to the feds," said Fred Silva, senior fiscal policy advisor with California Forward, a state budget think tank.

Silva said the closest California came may have been in the days after the 1994 Northridge earthquake, when at the request of the state, Washington sped up payment of federal funds that the state was owed.

State officials now fear they face a potential cash crisis worse than California confronted in 2003, in the final days of Schwarzenegger's predecessor, Gov. Gray Davis.

At that time, the precipitous decline of state revenue in the middle of a budget year forced officials to pay a syndicate of banks a premium of hundreds of millions of dollars for what amounted to an expensive "payday loan."

Even that option, administration officials say, would not be available during the current credit drought. They say if Congress does not approve a bailout plan -- and maybe even if it does -- there will be no lenders available to provide the state with the money it needs, regardless of the premium the state is willing to pay.

"We need to go as wide as possible to try to find buyers at reasonable rates," said Robert Fayer, an attorney advising the state on its planned $7-billion bond sale.

"Whether it could ultimately be the federal government, I have no idea. It is a fairly radical concept."